"A bird doesn't sing because it has an answer, it sings because it has a song." - Lou Holtz
Following the Summer Crash, Fall Melt-Up, and Winter Resolution series of writings, I've been making the case that a coming "Spring Switch" out of bonds and into stocks was likely sooner than later. I have admittedly been early in that call, as my company's own ATAC (Accelerated Time And Capital) models sensed a deflation pulse in April pushing us largely into defense mode out of stocks and into bonds for our clients. The disconnect between panic low yielding bonds and stocks remains, albeit with U.S. stocks very resilient. I spoke about this at length in a recent Bloomberg interview, which covers Europe, markets, and general risk-taking sentiment.
Junk debt has gotten a lot of inflows as a result of money reaching for yields when Treasuries don't come anywhere near compensating for inflation over a longer time frame. In many ways, if a "Spring Switch" out of bonds and into stocks were to take place, the "baby step" to that would be to go into Junk Debt which is the riskier of segments within the bond market. Credit spreads have continued to narrow despite concerns over Europe. However, if a Great Re-Allocation is coming sooner rather than later, and the 2012 reflation theme persists, than bond yields even on Junk Debt can rise alongside Treasuries. This means that all the money going into Junk Debt could lose out on a relative basis compared to stocks.
Take a look below at the price ratio of the SPDR Barclays High Yield Bond ETF (JNK) relative to the Russell 2000 (IWM). As a reminder, a rising price ratio means the numerator/JNK is outperforming (up more/down less) the denominator/IWM.
(Click to enlarge)
I'm comparing Junk Debt to Small-Caps here because in theory these are the riskiest segments of the bond and stock market respectively. Notice that Junk Debt has been outperforming since April, and is now hitting up against resistance. Should the ratio break through in a powerful way, stocks may continue to correct. However, despite being largely positioned in the short-term in bonds, I caution against those who are ultra bearish for reasons I laid out in my Bloomberg interview. The Siren Song may be beautiful, but could also put you on a path of hitting those rocks.
